A key question in the secondary growth of trees is how differentiation of the vascular cambium cells is directed to concurrently form two different tissues: xylem or phloem. class III homeodomain-leucine zipper (HD-Zip III) genes are known to play critical roles in the initiation, patterning, and differentiation of the vascular system in the process of primary and secondary growth. However, the mechanism of how these genes control secondary vascular differentiation is unknown. Here, we show that a Populus class III HD-Zip gene, PtrHB7, was preferentially expressed in cambial zone. PtrHB7-suppressed plants displayed significant changes in vascular tissues with a reduction in xylem but increase in phloem. Transcriptional analysis revealed that genes regulating xylem differentiation were down-regulated, whereas genes regulating phloem differentiation were up-regulated. Correspondingly, PtrHB7 overexpression enhanced differentiation of cambial cells toward xylem cells but inhibited phloem differentiation. PtrHB7 regulation on cambial cell differentiation was associated with its transcript abundance. Together, the results demonstrated that PtrHB7 plays a critical role in controlling a balanced differentiation between secondary xylem and phloem tissues in the process of Populus secondary growth in a dosage-dependent manner.